Analysts Bullish on Country ETFs

Analysts at Standard & Poor's are looking to exchange-traded funds rooted in individual countries as a vehicle for advisors and their clients to compensate for sustained weakness in the U.S. economy.

Country ETFs also offer an alternative to global sector ETFs, whose performance can be hindered by exposure to imperiled economies in Europe and Japan.

"We think a creative alternative to investing in industry sectors is through country ETF securities," S&P analysts Kenneth Leon wrote in a recent research note. "We believe this is a way to gain a higher percentage exposure to specific industries or sectors that an investor may favor."

The report is the latest optimistic submission from S&P on the investment potential for ETFs, which the firm has defended against the perception that many of the funds are risky because they are too new to have much of a track record.

The National Stock Exchange recently reported that cash inflows to ETFs and the related exchange-traded notes checked in at $73.2 billion year-to-date through August, up 54% from the same time last year.

But for those looking to avoid U.S. equities, S&P highlighted two funds that investors can tap into to tailor their international portfolio to certain sectors, looking to developed countries with a strong concentration of multinational corporations with extensive operations in emerging economies.

The first, the iShares MSCI Canada Index Fund (EWC), would support a commodities investment strategy, as the analysts noted that Canada is a major exporter of commodities associated with the oil and gas industries, along with other natural resources and materials.

Several aspects of EWC make it an intriguing choice for a country ETF in the eyes of S&P. The analysts noted that Canadian banks were comparatively sheltered from the fallout from the U.S. financial meltdown. Additionally, the country is poised for GDP growth of 2.6% for each of the next two years, according to Global Insight. That compares favorably to the more anemic growth rates that S&P is projecting in the United States and Europe over the same period.

EWC, with $5.5 billion in total assets, has seen a return of 8.23% over the past 12 months. Its three most heavily represented sectors are financials (32%), energy (25.8%) and materials (20.7%).

Measured by S&P's ranking methodology, EWC rates as “marketweight” in the categories of performance analytics, risk considerations and cost factors.

S&P is also looking favorably at the iShares MSCI UK Index Fund (EWU) as a comparatively safe foothold in the core European market that is undergoing a period of severe instability.

"Diversifying your portfolio outside U.S. equities generally means having some investments in Europe, Japan or Asia developed markets," Leon said. "We selected the U.K. market as a defensive investment theme."

EWU ranks favorably over other European Union country ETFs in part because the United Kingdom "has control of its destiny with its own currency," which could insulate if from the financial turmoil in countries such as Greece that threatens other EU member states.

S&P also described the Bank of England's policy throughout the recent financial downturn as "accommodative," noting that the policy interest rate has stood at 0.5% since March 2009.